Inflation and a Market Falling Apart

First on that CPI print Thursday. Inflation appears to be nowhere near going away any time soon. Here is the S&P (black), full CPI (blue), and the NY Fed’s Underlying Inflation Gauge, UIG (red):

The UIG expresses the main direction of inflation, and as the chart shows, UIG hasn’t even begun to round over.

The narrative is that inflation is caused by a “supply chain” crisis. But this big baloney sandwich gets wet when we examine the numbers on US trade. In the chart below, the black line is the S&P500 and the red line is the aggregate of US import plus export dollars:

So are we to believe that, despite the “congestion at the ports” (which are overwhelmed with clearly too much trade for the manpower at the ports to handle), that the supply chain issues - the shortages, are purely domestic?

I suggest the data points to the real reason for supply chain issues which is a lack of workers. Examine the next chart which shows JOLTS jobs openings data minus the number unemployed in the civilian labor force, in red, and the S&P500 in black:

There are clearly far to many job openings than there are bodies to fill these jobs. And yet, labor force participation rate (what percentage of the population is in the civilian labor force)

is clearly well below its February 2020 levels(not to mention the long term downtrend from its peak 22 years ago (or, the male-only labor force participation rate which has been in perpetual and steady decline since the data began being recorded in 1948. The shape of the curve, above, is solely a function of the female-only degree of labor force participation).

Gender differences aside, and whatever effects that might have on the nature of work or the nature of work not getting done, the supply/demand aspect of getting the millions needed in the labor force is a function of paying more.

Period.

That’s what motivates people to work.

And therein lies the problem. Despite all the clamor of earnings beats each quarter, etc., workers are making less, in the aggregate, after taxes and government handouts, when adjusted for inflation (and I am legitimately using YoY CPI here, not the YoY PCE measure so often used in these calculations which underestimates inflation even more than CPI).

The worker shortage gap will close when the redline, above, goes on to new highs. That is, when real (inflation-adjusted) disposable income (after tax income) less transfer receipts (government handouts), per capita, exceeds it’s recent highest level established in February, 2020.

And that will increase the cost of everything further. We have not yet felt the labor-induced aspect of inflation, but it will be felt and until then we should expect further supply chain issues.

And this is exactly what UIG is telling us as well.

As for stocks, we are clearly in a selloff, the tops having already been put in. Even forward earnings expectations are now being bumped down for the first quarter.

Inflation-adjusted EPS as a percent of stock price is a formidable metric for stocks. Any time we see this metric go negative post WW2, stocks have almost always otten clobbered and without a great deal of delay:

This has been negative for about a year now, so we’re overdue for a good, stiff market drop.

We mentioned in December we were heading directly into a 50 bps hike right around the corner, based on the Fed Funds - 2 year. That spread is now out to 142 bps, another ten bps and the Fed needs to find .75 bps hike quick, fast and in a hurry.

Credit Markets are responding and giving dire warnings now of an impending market free fall. For one, the HYG etf vs the SPY:

The HYG which tends to lead the way is in free fall here, the SPY still looking to try to hold the 420 level, a level we should expect to be blown right through per HYG.

Next, “Adams Apple,” names after Adam Robinson, its creator, which measures the etfs LQD/IEF to the S&P:

This credit market indicator is also well into a freefall now with readings as low as has been seen since late 2020, and below the Feb 2020 peak. Further, the Baa-10 year is closing the gap rapidly to it’s 18 month moving average, and should soon cross, a very negative sign.

For months the credit markets were no giving us bearish readings for stocks, but this has all changed abruptly now.

We believe the drop is on - right now, and that there is a very good chance this thing accelerates rapidly Monday and over the course of the coming week. One of the things to watch for, a metric overlooked by virtually everyone, is the daily number of new, 52 week lows on the NYSE. We look at this as a percentage of total NYSE issues traded. This is such an important metric, it should be a life-rule for every serious stock market trader. When the number of new lows exceeds 4% of the daily issues traded, you must be either flat, fully-hedged, or outright short until you at least have less than 4% of total issues being new 52-week lows. The chart below shows you days where new loes exceeded 4% of total issues for the day, vs a lognormal plot of the S&P:

This simple rule alone, which would have you going long or short on the close of a day where the 4% was met or not, yielded over 55,000 Dow points in theory since 1965. Every major market drop has seen new lows expand, and 4% of total issues has been a good threshold level, historically. So far this year, only ten trading days have witnessed less than 4% of total issues traded hitting new 52-week lows, and we are right, smack in the middle of a string of them right now:

Taken together, the prospects of the continuation of the bear market we are in, and a serious market selloff, are very high at this time. More as matters develop.